Canadian Appeals Monitor Information and Commentary on Upcoming and Recent Appeal Court Decisions

UK Supreme Court to Pierce the Issue of the Corporate Veil

Posted in Case Previews, Conflict of Laws, Contracts, Corporate Law
Brandon Kain

The UK Supreme Court has granted permission to appeal in a case that raises important issues regarding the legal doctrine of “piercing the corporate veil”.  The decision in VTB Capital Inc. v. Nutritek International Corp. will give the Court an opportunity to clarify when the veil should be pierced, and whether the legal effect of doing so is to constitute the company’s controlling minds as actual parties to its agreements in derogation from the privity of contract doctrine.  Given the many contexts in which veil-piercing is relevant, and the lack of definitive guidance about it from the Canadian Supreme Court, it is likely that the influence of the VTB case will extend beyond England into Canada, and indeed throughout the Commonwealth.

Background

The facts in VTB were discussed in an earlier post by my colleague, Tom Heintzman.  In brief, the dispute arose from a failed loan made by VTB Capital, PLC (“VTB”) to Russagroprom LLC (“RAP”), in order to fund the acquisition by RAP of six Russian dairy companies from the defendant, Nutritek International Corp. (“Nutritek”).  VTB was an English-incorporated company owned by a Russian bank, JSC VTB Bank (“VTB Moscow”).  With financial assistance from VTB Moscow, VTB made the loan to RAP, a Russian-incorporated company, by entering into a “Facility Agreement” with it, and by executing several other related agreements, including an interest rate swap agreement (“ISA”) with RAP.  When RAP defaulted on the loan, VTB sued Nutritek, a company incorporated in the British Virgin Islands, and two of Nutritek’s foreign affiliates, along with a Russian individual, Malofeev, who was alleged to be the principal beneficial owner and controller of Nutritek, its affiliates and of RAP itself.

VTB’s claim was initially framed in tort, and asserted that the defendants were liable for deceit and unlawful means conspiracy.  At the heart of the action was the allegation that Nutritek and its affiliates made two fraudulent misrepresentations that had induced VTB’s entry into the transaction:

1) they misrepresented to VTB that Nutritek and RAP were independent arm’s length entities who were not under common control; and

2) they misrepresented the value of Nutritek’s dairy companies to Ernst & Young Valuation LLC, which prepared a valuation report for VTB and VTB Moscow.

In 2011, VTB obtained an ex parte order permitting it to serve the defendants ex juris, as well as a worldwide freezing order over US$200 million of Malofeev’s assets.  The defendants moved to set these orders aside.  In response, VTB moved to amend its claim to assert that Malofeev and Nutritek’s affiliates were jointly and severally liable with RAP in contract for breach of the Facility Agreement and ISA, on the theory that the court should pierce RAP’s corporate veil.  VTB’s primary motivation for doing so was the fact that the Facility Agreement contained forum-selection and choice-of-law clauses in favour of England.  It sought to argue that, insofar as these defendants could be viewed as deemed parties to the Facility Agreement, then service ex juris could be validated against them based on the English forum-selection clause (or, failing that, based on an English CPR Practice Direction which permitted service ex juris in relation to contractual claims).

Decisions Below

The motions were heard together in November of 2011 by Arnold J.  In a lengthy set of reasons, he dismissed VTB’s motion to amend its claim, and granted the defendants’ motion to set aside the service ex juris order – and by extension the worldwide freezing order - since VTB had not demonstrated that England was clearly the appropriate forum in which to try the action.  In rejecting VTB’s proposed amendment, Arnold J. concluded that even if RAP’s corporate veil were to be pierced, the legal consequence of that could not be to render the provisions of the Facility Agreement and ISA enforceable against the defendants.

On June 20, 2012, Arnold J.’s judgment was affirmed by the English Court of Appeal.  Lloyd L.J., who delivered the unanimous judgment of the Court, began by rejecting the proposition that there is no principle of “piercing the veil”. (para. 48)  Instead, Lloyd L.J. accepted that “there is one (and apparently only one) special case justifying a court in looking behind a company’s corporate faҫade”, being where ”special circumstances exist indicating that it is a mere faҫade concealing the true facts”. (paras. 48-49)  He went on to observe:

“… In cases in which that is done, the authorities show that it will or may lead to the granting of remedies against the company which, veil piercing apart, might appear in principle to be available only against those controlling it; and, equally, against the controllers when they might appear in principle to be available only against the company.” (para. 47)

Lloyd L.J. also held that the Court was competent to pierce the corporate veil even where it was not “necessary” in the sense of there being no other remedy available against the wrongdoers for the wrong they committed.  He then proceeded to agree with the following statement of principles:

“… First, ownership and control of a company are not of themselves sufficient to justify piercing the veil. Second, the court cannot pierce the veil, even when no unconnected third party is involved, merely because it is perceived that to do so is necessary in the interests of justice. Third, the corporate veil can only be pierced when there is some impropriety. Fourth, the company’s involvement in an impropriety will not by itself justify a piercing of its veil: the impropriety “must be linked to use of the company structure to avoid or conceal liability”… Fifth, it follows that if the court is to pierce the veil, it is necessary to show both control of the company by the wrongdoer and impropriety in the sense of a misuse of the company as a device or faҫade to conceal wrongdoing. Sixth, a company can be a faҫade for such purposes even though not incorporated with deceptive intent…” (paras. 78-79, emphasis in original)

Thus, in order to pierce the corporate veil, Lloyd L.J. accepted that ”[t]he relevant wrongdoing must be in the nature of an independent wrong that involves the fraudulent or dishonest misuse of the corporate personality of the company for the purpose of concealing the true facts”. (para. 80)

Based on these principles, Lloyd L.J. found that VTB had established at least an “arguable” case that it was appropriate to pierce RAB’s corporate veil. (para. 49)  The issue before the Court, then, was whether the legal consequences of piercing RAB’s corporate veil could be such as to render Malofeev and Nutritek’s affiliates “original parties” to the Facility Agreement and ISA.

It was here that VTB’s claim failed.  After engaging in a detailed review of the English authorities, Lloyd L.J. found that they did not support the proposition that a court which pierces the corporate veil can go beyond granting equitable relief against the company or its controlling mind, and in fact deem the controlling mind to be an actual party to the company’s contracts. In doing so, he rejected the analogy which VTB sought to draw to the liability of undisclosed principals for contracts entered into by their agents.  According to Lloyd L.J.:

“… VTB’s submission amounts to the proposition that there is a principle of English law that a person can be held to be a party to a contract when, assessed objectively, none of the undisputed parties to the contract had any thought that he was, let alone an intention that he should be. In our judgment, to accede to VTB’s submission would be to make a fundamental inroad into the basic principle of law that contracts are the result of a consensual arrangement between, and only between, those intending to be parties to them. It is contrary to that principle, which is applicable save in some exceptional cases, none of which applies here, that a stranger to the contract should be held to be a party to it.

… The reported authorities certainly proceed on the basis that (in the usual case) the puppet company and the controlling puppeteer are to be closely identified, an identification that will or may be regarded as justifying the grant of a judicial remedy against the puppet as well as the puppeteer, if only on the basis that it will be just and convenient to do so. They do not, however, go to the length of treating the puppet company as other than a legal person that is formally distinct and separate from the puppeteer; and, were they to do otherwise, they would wrongly be ignoring the principles of Salomon. Consistently with that, they do not provide any basis for the proposition that the puppeteer should be regarded as having always been a party to a contract to which it or he plainly was not a party.” (paras. 90 and 94)

Lloyd L.J. also concluded that it would be inappropriate to extend the common law in the manner suggested by VTB:

Not only do we not regard the common law as recognising the principle for which VTB contends, we are also not persuaded that it would be a principled development of the law for us to recognise it by our decision in this appeal. Any such development would not be a modest development of existing principle. It would, in substance, amount to the adoption by the courts of a jurisdiction to subject parties to contractual obligations under a contract to which neither they, nor the only undisputed parties to the contract, had ever agreed or intended that they should be subject. Yet further, if, which we question, it would ever be appropriate to develop any such principle, we do not regard this case as the right one in which to do so. There is no need to do so. Mr Snowden submitted that English law needs the tools to deal with commercial fraud. In principle, we agree. But if VTB’s factual assertions are well founded, English law already provides it with a perfectly good remedy against the defendants, by way of a claim in the tort of deceit for the wrong which it claims they have inflicted upon it. There is no good policy reason for inventing and giving it an artificial remedy in contract, which VTB does not need, but which it merely invokes in support of its claim that the English courts should assume jurisdiction in its claims. In this context, Mr Lazarus referred us to the cautionary words of Lord Goff of Chieveley in Kleinwort Benson Ltd v. Lincoln City Council [1999] 2 AC 349, at 378A to D, as to the manner in which the judges do or should develop the common law. We have had regard to them.” (para. 95)

Potential Significance

As noted earlier, the UK Supreme Court’s ruling in VTB is likely to be of great significance to courts and commercial lawyers throughout the Commonwealth.  Three aspects of the judgment in particular may be of interest.

First, the Court could shed further light upon the test to be applied in determining whether to pierce the corporate veil.  The current formulations of this test are often vague (e.g., “a mere faҫade concealing the true facts”), and several different versions of it abound.  As the Supreme Court of Canada observed in Kosmopoulos v. Constitution Insurance Co., “[t]he law on when a court may… ‘lif[t] the corporate veil’ and regarding the company as a mere ‘agent’ or ‘puppet’ of its controlling shareholder or parent corporation follows no consistent principle”.  In Kosmopoulos itself, the Court suggested that it would be appropriate to pierce the corporate veil where to do otherwise “would yield a result ‘too flagrantly opposed to justice, convenience or the interests of the Revenue’”.  This broad statement has proven troublesome for lower courts, which have been left to impose their own restrictions upon the ability to pierce the corporate veil, often by drawing heavily from English jurisprudence.  If the UK Supreme Court were to articulate a more concrete test, it would likely have a profound influence in Canada.

Second, the VTB case will be important in clarifying the remedies that are available where the veil is pierced.  If the Court of Appeal’s judgment is affirmed, then it would suggest that the effect of piercing the corporate veil cannot be to constitute a company’s controlling mind as an actual party to the company’s contracts.  This may have far-reaching implications, not only in the conflict of laws context at issue in VTB itself, but in other contexts as well (e.g., commercial disputes, tax planning, family law, employment law, etc…).  Conversely, if the Court’s judgment is reversed, it would confirm the existence of an important exception to the privity of contract doctrine, and may call for a rethinking of the ”separate legal entity” principle that has dominated Anglo-Canadian corporate law since the ruling in Salomon v. Salomon & Co., [1897] A.C. 22 (H.L.).

Third, although not discussed by the Court of Appeal or Arnold J. in VTB, there may also be an important conflict of laws issue lurking in the background here.  The company whose veil VTB sought to pierce, RAP, was incorporated in Russia.  It is arguable, therefore, that the test for and legal consequences of piercing RAP’s corporate veil should be governed by Russian law, and not by English law as seems to have been assumed by both courts below.  On the other hand, given that the issue in VTB was the effect which piercing RAP’s corporate veil would have upon the defendants’ liability under English-law governed contracts, an argument can also be made that this issue was appropriately determinable under English law.  In either case, it will be intriguing to see whether this choice of law issue, which has received little judicial attention in both Canada and abroad, is ventilated before the Supreme Court.

Case Information

Case Name: VTB Capital Inc. v. Nutritek International Corp.

Case ID: UKSC 2012/0167

Date Permission to Appeal Granted: July 26, 2012